Vijay Kumar Gaba

Thursday, December 12, 2013

Wednesday, December 11, 2013

Positioning for May 2014

Thought for the day

“Never accept ultimatums, conventional wisdom, or absolutes.”

-Christopher Reeve (American, 1952-2004)

Word of the day

Calorifacient (adj)
(of foods) producing heat.

(Source: Dictionary.com)

Shri Nārada Uvāca

After bank license, now Tata’s do not want airport!

Will we see Tata House shifting from Mumbai to Dublin in next one decade?

Positioning for May 2014

As suggested yesterday, expecting any substantial improvement in macro fundamentals of the economy in 2014 could lead to disappointment.

In our view, the best thing that could potentially occur in 2014 due to change in government is improvement in execution of existing plans, programs and projects. We however do not agree with the consensus that the improvement in execution would completely depend on the outcome of the elections.

In our view, irrespective of the constitution (UPA, NDA or third front) or nature (minority or majority) of the government the tremendous public pressure, heightened fiscal pressure and elevated inflation would ensure faster execution. Consequently, we would not be too disappointed if BJP fails to form a government led by Narendra Modi (not our base case).

Given that the 2014 elections are likely to be fought very aggressively, and acrimoniously we do not see political consensus evolving on key social, economic and financial sector reforms till the tempers cool down (may be couple of years down the line).

In our view, therefore, the limited implications of general elections in terms of industry performance would be better visibility of order flow for capital goods from 2015, improvement in working capital cycle. Improvement in capacity utilization level would depend on the correction in inventory level, pick up in consumption demand and higher government plan expenditure.

We also note that global economic cycle is stabilizing and may show further improvement in 2014. This could have positive implications for Indian industry in terms of better external demand environment, especially when INR is likely to remain weak. Growing participation of global corporations in Indian industrial landscape by way of expanding operations (HUL, Cadbury, Nestle, Vodafone etc.) or increasing stakes in existing operations is a key trend to follow.

We therefore would like position for May 2014 through:

(a) Industrial companies with substantial operating leverage and lower financial leverage. The companies with market and technology leadership, strong brand equity and access to global markets would be preferred. Examples would be Siemens, Cummins, and L&T etc. Product companies rather than services companies are more preferable as they gain from inventory correction, pricing power among other things.

(b) Consumer companies both in staple and discretionary space which may benefit from weaker INR, lower commodity prices, rising demand post bumper Rabi harvest and rising consumption demand in external markets. Examples would be HUL, ITC, Maruti, Bajaj Auto, Tata Motors, Tata Global Beverages, and Dabur, etc.

(c) Local units of global corporations that may see larger participation through more investment, hike in stake or transfer of manufacturing operations for regional exports. Examples would Bayer, Bosch, Siemens, Cummins, United Spirits etc.

We would continue to avoid PSUs, commodity stocks and leveraged infrastructure companies.

Tuesday, December 10, 2013

What to expect from the new government post 2014 election

Thought for the day

“Old age and treachery will always beat youth and exuberance.”

-David Mamet(American, 1947- )

Word of the day

Hardihood (n)
Boldness or daring; courage.

(Source: Dictionary.com)

Shri Nārada Uvāca

Should Congress take solace from the fact that its 3/5 for BJP and not 4-0 as many pools projected!

Will Congress become a “Party of smaller states” – HP, UK, Mizoram, Haryana, Arunachal, Manipur and Meghalaya – post 2014-15 elections.

Assam, AP, and Karnataka are the only larger states where Congress is in power on its own. It shares power in J&K, Maharashtra, Jharkhand and Kerala.

What to expect from the new government post 2014 election

The general mood in Indian financial markets had been rather optimistic since announcement of Mr Narendra Modi as PMship candidate of principle opposition party BJP. The results of recently concluded state assembly elections have provided further impetus to the optimism. The response of equity market yesterday reflected the optimism of financial investors.

In our view, the optimism is well guarded, mostly optical and should not be mistaken for any imminent improvement in the macroeconomic or corporate fundamentals.

It is pertinent to note that:

(a) The volumes and market breadth in equity markets are not at all commensurate with the gains in benchmark indices. The participation rate (average number of investors/traders trading and average number of scrips traded on daily basis) has not seen any notable improvement.

(b) Bond yields have actually risen since September.

(c) RBI efforts (swap window for banks and OMCs, curb on gold import) and fall in domestic demand have restored stability in INR. However, the consensus believes that from hereon INR should see orderly depreciation over next many years as India attempts to correct many of its structural imbalances. Recent political developments therefore have little or no implications for the currency.

(d) Despite expected bumper Rabi crop, food inflation is not expected to ease below 8% in 2014. The core inflation at ~4% may continue to remain benign as the global growth fails to pick up substantially.

(e) As the global liquidity expectations tighten and bond yields rise, the lending rates in India may continue to remain elevated for at least 12-15months.

(f) In absence of any substantial improvement in tax collections, the fiscal balance will continue to remain tight, especially if Food Security expenses cover for the savings in fuel subsidies.

(g) The business confidence will likely see substantial improvement. However, investment cycle would improve substantially only if the process of balance sheet correction is accelerated. This is certainly not good omen for most banks. The exuberance seen in banking stocks may therefore be unfounded.

The best thing that could potentially occur in 2014 is improvement in execution of existing plans, programs and projects. The implication in terms of industry performance would be better visibility of order flow for capital goods from 2015, improvement in working capital cycle. Improvement in capacity utilization level would depend on the correction in inventory level, pick up in consumption demand and higher government plan expenditure.

Tomorrow we shall discuss how it may translate in terms of equity price performance.

Monday, December 9, 2013

Congress losses semi final; captain retired hurt

Thought for the day

“Most of us spend too much time on the last twenty-four hours and too little on the last six thousand years.”

-Will Durant (American, 1885-1981)

Word of the day

Largesse (n)
Generous bestowal of gifts.

(Source: Dictionary.com)

Shri Nārada Uvāca

Morarji Desai (1977); V. P. Singh (1989); NTR (1982); Praful Mahanta (1985) Arvind Kejariwal (2013)?

A quick telephonic survey of 28 young finance professionals - 16 were not aware if V. P. Singh is dead or alive; 13 thought Morarji Desai was a RSS colleague of Atal Bihari Vajpayee and no one remembers who were three main leaders who founded AGP!

Congress losses semi final; captain retired hurt

The results of recently concluded four state assembly election, though not unexpected, would have surprised most. The key highlights of the results are (a) The people have mostly continued with the trend seen in past 3-4years by giving a decisive mandate at the state level; (b) complete and total decimation of Congress Party; (c) strong performance of the newly formed Aam Aadmi Party (AAP) and (d) stupendous victories of Shivraj Singh Chauhan and Vasundhara Raje in Madhya Pradesh and Rajasthan respectively.

The elections which were widely seen as semi final of the general elections due in 4months, have provided some very interesting trends. For example consider the following:

(a) In Delhi, Congress lost its traditional Muslim, SC and lower caste vote in Delhi to AAP. BJP failed to win central government employees who also went with AAP. But in MP and Rajasthan BJP gained votes from both BSP and Congress.

These trends could be crucial during 2014 general election in UP and Bihar. A change in voting pattern of Muslim, OBC and SC voters in favor of BJP in these states could be a major swing factor.

(b) Encouraged by Delhi results, AAP could take their chances in other metropolis, e.g., Mumbai, Bangalore, NOIDA where conditions are fertile for their kind of politics to take root.

(d) The detractors of Narendra Modi within BJP have got another chance; though they may not want to express their dissention before 2014 election. In case, BJP falls well short of 200 seats in 2014 election, Shivraj will definitely emerge as consensus leader around which a larger coalition could be stitched.

Implications

The results of just concluded state assembly elections, in our view, will certainly have far reaching implications for various parties in particular and general political environment in general. For example consider the following:

(a) The chasm between old feudal lordship within Congress Party and young turks has been widening since past few years. Loss in 2013 elections will embolden the old guards. With Mrs. Sonia Gandhi not in best of her health, and Rahul being repeatedly rejected by the people of India, we might see some Kamraj, Morarji Desai, Jagjiwan Ram, Biju Patnaik, Mamata Banerjee, Jagan Reddy Mohammed Alimuddin and Bhajan Lal sort of rebellion against the family. Nonetheless there could certainly be more episodes of Kamalapati Tripathi, Sharad Pawar and Sitaram Kesari sort of misadventures.

Rahul Gandhi in “acknowledgement of defeat” press interaction highlighted that the feudal elements in Congress Party have not heeded to his suggestion of changing the way party has traditionally worked. He said that he would pursue his agenda more aggressively going forward.

(b) Priayanka Gandhi has not been tested yet, but in our view, faced with such a situation she may not be as successful as Mrs. Indira Gandhi was in overcoming the threat from Syndicate in late 1960’s.

(c) Absence of any recognized national level leader outside Gandhi family will encourage more secession on lines of Sharad Pawar, Mamata Banerjee, Jagan Reddy, et al. This could be especially true in case of states where Congress enjoys reasonably higher vote share but is doing poorly in terms of electoral wins, e.g., UP, Madhya Pradesh and Gujarat.

(d) With Narendra Modi at the helm, the secularism vs. communalism debate will become almost irrelevant breaking the very fulcrum of opportunist alliances that have kept Congress and some regional parties like RJD in contention since mid 1990’s. The disenchantment of Muslim voters with Congress Party in recent elections indicates to this trend.

In a communally neutral political environment the regional parties would be more amenable to BJP which does not compete with many of these at state level and has demonstrated better track record in center – state relations.

(e) With Congress likely out of power for 5years, much reduced strength in Rajya Sabha and only a few states under its rule (forecasts suggest it losing Andhra Pradesh too, leaving it with just one big state under its rule, i.e., Maharashtra) the already meager cadre may further splinter away, making a comeback even more unlikely.

(f) Congress Party in panic may reverse its decision of going alone in the election in the key states like UP and Bihar. This would structurally weaken the Congress as they would get much fewer seats to contest and therefore find it difficult to retain their flocks together.

(g) Modi effect is clearly visible in the state election results. Despite strong undercurrent in favor of AAP and bitter infighting in BJP, the party has been able to retain its traditional voter base. In MP and Rajasthan it has broken new grounds. In Chhattisgarh, despite a strong sympathy wave in critical tribal areas of Bastar, BJP could scrape through. Weakening of Congress Party could further aid in strengthening of this trend.

Modi will however need to change his strategy to positive campaigning from mere Congress bashing as that space is crowded and regional parties might have edge over BJP in that space. The performance of AAP will certainly encourage the regional parties to adopt an aggressive anti UPA strategy.

(h) It is also clear that Modi alone will not be sufficient to take BJP home. BJP would need a strong local leadership to gain new grounds. The key states of UP, Haryana, West Bengal, Karnataka, Andhra Pradesh, Assam and Maharashtra etc. still do not have strong and popular leadership.

(i) India shall now move even faster towards a truly federal structure of governance with strong state leaderships and a “cooperating” central administration.

Tomorrow we shall discuss the socio-economic implications of the results.

Thursday, December 5, 2013

Investment Strategy - II

Thought for the day

“In a world where every event is identical to a previous event no change would ever occur.”

Peter L. Bernstein (American, 1919-2009)

Word of the day

Pokelogan (n)
Marshy or stagnant water that has branched off from a stream or lake.

(Source: Dictionary.com)

Shri Nārada Uvāca

Is it healthy for democratic traditions to presume a “demand for debate” as “opposition”?

Investment strategy - II

As the world endeavors to slither out of the fiscal crisis, a new global economic order takes shape and India’s socio-economic transition to a truly federal governance structure that is transparent, accountable gets established over next decade or so, Indian businesses will face numerous challenges.

Historically, a large majority of Indian businesses have grown on government patronage and/or resource arbitrage opportunities and have been low on innovation, productivity and scale. The politically advantageous socialistic façade of the government, especially during 1950-1990 led to misallocation of resources, trade and capital controls, demand suppression, and protectionism that promoted low productivity. The conditions have changed in past 10-15years but not sufficiently to make a majority of Indian businesses globally competitive.

The following trends, which are quite likely to strengthen in next few years, would suggest that a large number of small, over protected, less productive, uncompetitive, under-capitalized businesses should become extinct in next decade or so.

In past two decades we have seen this happening with small steel and cement plants, textile manufacturers, petrochemical plants, numerous public sector undertakings, NBFCs, etc. There is no reason why it should not happen to (a) small and mid-sized engineering and construction companies which purely survive on administrative patronage: (b) ITeS providers who are pure commodity plays solely focused on wage arbitrage opportunities; (c) mid-sized commodity producers who cannot scale up to compete with global corporations in a more open, price & quality competitive and transparent market; (d) intermediaries who are not adequately capitalized and technologically prepared to serve or compete with large global businesses which are highly price sensitive.

1. The cost structure of Indian businesses shall move up structurally due to higher wage inflation, rise in effective tax rates, higher compliance (social, legal, environmental) cost, higher cost of capital and rise in cost of resources like land, minerals, water etc.

2. Given the non-linear rise in consumption demand, the investment demand shall rise faster, in a period when global cost of capital would have bottomed out and begin to rise. India has clearly missed the advantage which China enjoyed by investing and building huge capacities in an era of lower interest rates. This shall force us to be governed by the terms set by the capital providers, essentially opening our markets to global competition. What we saw in case of FDI in retail might just be a small trailer of the things to come.

3. The global competition and rising cost should squeeze the margin and hence force the small and mid-sized businesses out of arena.

In our view, there is little opportunity in India’s SME segment at this juncture. Only the businesses which have shown the capability to take the game in global arena look promising. Otherwise stick to the large Indian MNCs – if one is looking at a really long-term horizon (5-10years).

Wednesday, December 4, 2013

Investment strategy

Thought for the day

“All you need is ignorance and confidence and the success is sure.”

Mark Twain (American, (1835-1910)

Word of the day

Twain (adj)
Two.

(Source: Dictionary.com)

Shri Nārada Uvāca

Why the Mint Street is not celebrating the victories over current account and fiscal deficits?

Is Dalal Street missing something which Mint Street could see clearly?

Investment strategy

The rays of optimism emanating from slight stabilization in macro fundamentals and above expectation 2QFY14 corporate performance has attracted foreign investors’ interest in Indian equities; though the domestic investors have mostly remained on the sidelines.

Despite low participation and late rise in volatility, Indian equities have been rather resilient. Nifty has averaged ~5900 in YTD 2013, much higher than 2010 (5468), 2011 (5352) and 2012 (5363). The collective wisdom of the market therefore appears to be much more sanguine about the economic conditions, and therefore corporate performance. Off late sell side analysts have also changed their stance to neutral with a mild positive bias.

From here on, in our view, the upside triggers would mostly be domestic, e.g., improvement in macro fundamentals, improved political environment post 2014 election, inflation peaking out next year on high base effect, peaking of rates, improvement in external trade, and pick up in investment cycle.

The earnings profile of large corporates with geographically diversified global business profile could help aggregate earnings numbers to show a better picture from 2HFY15. Though, mid and small enterprise should continue to struggle and post poor performance. The financials therefore would continue to experience deterioration in asset quality.

The 15-20% higher index levels will thus mostly be a consequence of 15-20% higher earnings .over FY14-FY16 rather than any multiple expansion. The multiple on the contrary might see some contraction at aggregate level. However, we may see some multiple expansion in capital goods, infra and financials while multiple of defensives contract a bit.

The caution here is that given the deposit rates persisting at high level due to savings deficit the domestic participation in equities is not likely to rise in any substantial manner. Moreover, the foreign participation in Indian equities has so far been mostly generic (EM) rather than Country specific. We do not see how the prospects of Nifty rising 15-20% would motivate foreign investors to specifically invest in “Indian equities” in a major way, as in all likelihood the currency will remain under pressure, rates will likely peak at elevate level and other EMs will likely outperform India should US and EU economies stablize.

The rise in domestic participation and return of EM generally in favor is therefore the key to the bull case for the market.

The downside risk to the market would mostly be due to external factors. Historically, large FII flows in a short period of time have caused huge volatility in Indian equity markets. A reversal of USD carry trade, if and when US Fed decides to moderate liquidity conditions in US, will certainly cause this event.

Though in our view, the liquidity moderation would not be disruptive to the global economy, in the short term it will certainly lead to global rise in cost of capital and weakening of currencies with higher CAD, like INR.

Under these circumstances, it would therefore be appropriate to focus on businesses that have (a) low beta to domestic macro fundamentals; (b) would not be materially impacted by global liquidity event and consequent rise in cost of capital and (c) would benefit from stable external demand environment.

Tuesday, December 3, 2013

…but harvest time may still be 2-3years away

Thought for the day

“Who can love to walk in the dark? But providence doth often so dispose.”

Oliver Cromwell (English, 1599-1658)

Word of the day

Pilcrow (n)
A paragraph mark.

(Source: Dictionary.com)

Shri Nārada Uvāca

8 gang rapes in 8months in Mumbai!

As we approach the first anniversary of notorious Delhi rape case (16 Dec), do we need to reassess the corrective and preventive measures taken so far?

…but harvest time may still be 2-3years away

The trend growth decline that began from FY09 may not bottom before end of FY16, even if we accept the rather bullish estimates of government agencies

In our view, it is pertinent to keep a watch on the periodic macro data. But it is often not appropriate to let these data lead a substantial change in the direction of investment strategy. A profitable investment strategy, in our view, needs to be based on medium to long term growth magnitude and direction.

Insofar as the current medium to long term growth trend in India is concerned, in our view, the trend growth decline that began from FY09 may not bottom before end of FY16, even if we accept the rather bullish estimates of government agencies.

The resumption of up move in medium term trend growth would only lead to a stable growth environment in the country and sustainable gain in equity prices, because a sustained growth over medium term would only-

(a) bridge the output gap and create demand for investment;

(b) lead to creation of productive employment opportunities;

(c) provide fiscal leverage to government for increasing social sector spending and thus increasing the sustainability of growth;

(d) lead to stability in prices as more capacities are added;

(e) lead to sustainable monetary easing as fiscal condition improves; and

(f) lead to rise in private income and savings, thus providing impetus to private consumption;

In our view, the potential growth of India under current circumstances is not more than 6%. Growing at 5-6% in the current direction would not lead to enough employment opportunities and strong consumption story will not remain sustainable. Agriculture, as we have seen in past couple of years is still “God” driven. Basing an investment strategy on God’s will alone is not advisable in our view.

(Source: CSO. InvesTrekk Global Research)

Also read Green shoots seen…